Wednesday, October 31, 2012

As Hurricane Sandy hit the US east coast, the WSJ reported that institutions found work-arounds for trading their portfolio:

Even with the U.S. stock market closed, investors found ways to trade. "You can work around it to a certain extent," said Nanette Buziak, head of equity trading at ING Investment Management. On Monday morning, "where I would have been trading in stocks, we ended up trading what we needed to in futures. We're also still trading where we need to in international markets."

This brings to mind the risks of market manipulation. Even with a relatively thin market, traders can find work-arounds to arbitrage away attempts at manipulation. Consider this New York Times story about the Romney contract on intrade.com about a week ago [emphasis added]:

For a moment it looked as if Mitt Romney’s chances of becoming the next president were up, way up.

His odds of winning the election soared around 10 a.m. Tuesday to nearly 49 percent on the betting site Intrade, up about eight percentage points from a few minutes earlier.

The numbers on Intrade, which have put the odds of President Obama’s winning on Nov. 6 at over 60 percent for the last several weeks, are closely watched by pundits and Wall Street traders because they are constantly updated based on wagers on the changing election odds. In 2008, the site’s users correctly predicted an Obama victory.

But the system is relatively thinly traded and so a few politically motivated bettors with money to burn can place strategic wagers that push around the numbers displayed on the site.

Was it an attempt at manipulation or just a naive trader pushing up the price of the Romney contract?
As I write these words, the intrade Obama contract is steady at about 63% and Romney at 37%, which are roughly the levels they were at during the summer.

If I had a few bucks to throw around and I was intent on moving the presidential election odds around in Romney's favor, here is what I would need to do in order to cover all the "work-arounds" that other traders would try. First and foremost, I would push the price of the Obama contract down and the Romney contract up and I would need sufficient capital to maintain them at the levels I want.

Next, I would need to manipulate the prices at the state level on intrade. Perhaps push CO and VA into the leaning Republican category and move OH into either a tossup or leaning Republican state. Since those contracts are relatively thin, it shouldn't be that hard to move them and maintain prices at desired levels.

Even though trading on intrade is relatively thin, don't forget that intrade prices can be arbitraged. So don't forget to push the odds around on UK-based sports betting sites such as Ladbrokes:

Whew! Market manipulation is hard! That's because markets are relatively efficient, at least in a crude way. Even in thin markets, the Invisible Hand can find work-arounds if the market manipulator isn't careful.

The moral of this story: If intrade odds move around in a dramatic fashion between now and election day, look at these secondary indicators to gauge if someone is trying to manipulate markets in order to give a false picture.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, October 29, 2012

My asset inflation-deflation timer model moved to a neutral position last week, indicating that investors should take some risk off the table. My analysis suggests that this is not a run for the bunker call, but a call for a volatile market without a great deal of direction.

Trend breaks everywhere
To set the stage, there were trend breaks everywhere. The SPX decline through its 50-day moving average and a upward sloping trend line that began in June (shown in blue), but the longer term uptrend (in red) remains intact and the index remains above its 200-day moving average. This is not a disaster, nor is is a market crash warning.

This trend break were confirmed by intermarket analysis. The price action of other averages showed similar kinds of sideways action of broken trend lines. As an example, the STOXX 600 moved through its 50-day moving average, though it is now testing an important support zone.

Commodity prices also displayed similar levels of weakness. Dr. Copper, which is one of the most important industrial commodities, has been falling and is now testing an important technical support as represented by its 50% Fibonacci retracement level.

The bull case
While the technical damage is evident, these are not portents of impending disaster. There are good reasons to be bullish and much could still go right in the macro environment.

Europe is cheap and its tail risk is highly diminished. Sure, the eurozone is in recession, but the ECB has taken tail risk off the table and a glance at the Euro STOXX 50 ETF (FEZ) shows the trailing P/E ratio (none of this forward P/E funny stuff) to be 11 and the dividend yield at 4.2%. How much cheaper do you need European equities to get?

The US economy continues to grow. Housing continues to be a bright spot. Employment and consumer spending continue to see upside surprises. Continuing claims continue to see positive surprises and Gallup's tracking poll shows the unemployment rate cratering and I will be taking the "over" bet in the NFP sweepstakes this coming Friday [emphasis added]:

U.S. unemployment, as measured by Gallup without seasonal adjustment,is 7.3% in mid-October, down considerably from 7.9% at the end of September and at a new low since Gallup began collecting employment data in January 2010. Gallup's seasonally adjusted unemployment rate is 7.7%, also down from September. October's adjusted mid-month measure is also more than a percentage point lower than October 2011.

While the major averages have declined through their uptrends, sentiment indicators are still supportive of an advance. At the very least, major declines generally do not begin with readings at these levels. The AAII sentiment survey (via Bespoke) shows the percentage of bulls to be well below average, which is contrarian bullish:

The CS Index of risk appetite (via Sober Look) is still rising, indicating that the bulls still enjoy the upper hand.

Bear case: It's all about valuation and earnings
In the face of these reasons to be bullish, I have been struggling with the fundamental reasons for the recent sloppy market action. My conclusion is that market psychology is in transition to one that focuses on top-down macro disaster risk to a more traditional market that focuses on valuation and earnings.

From a long term valuation viewpoint, equities aren't screamingly cheap.This chart of market cap to GDP (via Vector Grader), which is analogous to an aggregated price to sales ratio for the US economy, shows market cap to GDP ratio to be still above its long term average and it is declining. At the current rate of decline, the stock market may see a generational bottom around the end of this decade.

Similarly, Chart of the Day showed a longer term perspective for the market's P/E ratio and, despite the fall, P/E ratios are not at the bottom of its historical range where long-term investors should be buying:

What's more, the earnings in this Earnings Season have been punk. Despite going into reporting season with very low expectations, the earnings beat rate is only about the same level of historical beat rates, sales reports have generally been coming in below expectations and guidance has been negative.

I would attribute the disappointing earnings reports to a bifurcated growth rate in the US economy. While consumer confidence and employment have been rising, business confidence and capital investment has been falling. My hypothesis is that the returns to capital vs. labor got over-stretched and the balance is starting to swing towards labor. That's why we are seeing better employment and consumer confidence, but the returns to capital are diminishing and the earnings disappointment that we are seeing now is the result of margin compression. While the American economy will likely continue to growth, stock prices may not follow because margins - and therefore earnings are getting squeezed.

Take a look at this chart of the divergence between the consumer confidence and business confidence. I proxied the former with the University of Michigan consumer sentiment (in blue) and real retail sales (red) and proxied business confidence with Manufacturers' new orders (green).

A recipe for volatility
The bottom line is the current environment is a recipe for continued volatility and choppiness. Bulls have much to look forward to and bears are anticipating a transition to a market where earnings matter more - and the earnings outlook is disappointing.

Barry Ritholz also turned more cautious last week and I generally agree with his assessment:

I don’t imagine we go straight down from here; There will be sell offs and rallies, pre and post elections. There will be some data points that suggest things aren’t so bad, and then some that are awful. It is not a black and white situation. I do believe the low volatility we have seen may very well become a thing of the past, and the VIX is becoming a definitive Buy.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Wednesday, October 24, 2012

At the height of yesterday's (Tuesday's) market selloff, I was asked, "Are you throwing in the towel?"

My initial reaction was, "Not yet, but getting close." After the market close, I reviewed Tuesday's market action and revised my conclusion: These are not the kind of conditions where intermediate term declines normally begin.

Let me explain by recapping how Tuesday unfolded. The day began with weakness in the European bourses. Yet, a glance at the relative performance of eurozone equities against the MSCI All-Country World Index (ACWI) shows that Europe remains in a relative uptrend. No signs of any technical breakdown there.

As the market opened in New York, stocks were hit by earnings disappointment from the deep cyclical Dupont (DD), which saw a selloff on huge volume.

Does this mean that cyclical stocks are finished? Is it time to throw in the towel? Not quite. In fact, the Morgan Stanley Cyclical Index (CYC) actually outperformed the market on the day. Is this a picture that suggests Mr. Market it's all over for cyclical stocks?

Measures of risk appetite, such as the relative performance of Consumer Discretionary to Consumer Staple stocks actually advanced on the day. Does this look like a panic selloff? Or an indication that someone is accumulating the high beta Discretionary stocks on weakness?

To be sure, not all is well with cyclical indicators. In particular, the behavior of Dr. Copper is a concern. Copper staged an upside breakout in early September and attempted a high level consolidation, but failed. Now it appears to be testing the former breakout level of 3.55, where technical resistance turned support.

Indeed, the relative performance chart of Chinese stocks (FXI) against ACWI is reflecting that view as FXI rallied strongly in early October and broke out of a relative downtrend.

In short, my inner trader's advice is not to panic. Market internals suggest that the trend remains up. Tactically, traders should be giving the bulls the benefit of the doubt (for now).

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Tuesday, October 23, 2012

Over at VIX and More, there is an excellent discussion of the contango observed in VIX futures, i.e. upward sloping implied volatility curve as time extends. MarketSci also followed up with a terrific animation of how the VIX contango has developed over time. Here is the key takeaway:

The important takeaway is not necessarily how strong contango is today, but how consistently strong contango has been this year (which is why 2012 shows as such an outlier in V and M’s chart).

One conclusion to be drawn from the term structure of VIX is that Mr. Market is short-term bullish, but longer term cautious.

What happened with Caterpillar?
A case in point is what happened with Caterpillar (CAT) yesterday. CAT is an important bellwether of the global capital equipment sector as it operates all over the world. The company reported earnings before the opening bell yesterday. It beat earnings estimates, but missed on sales estimates and lowered its forecast for 2012. Here is the statement [emphasis added]

We now expect 2012 sales and revenues to be about $66 billion and profit in a range of $9.00 to $9.25 per share. The previous outlook for sales and revenues was a range of $68 to $70 billion with profit of about $9.60 per share at the middle of the sales and revenues outlook range.

The decline in the sales and revenues outlook reflects global economic conditions that are weaker than we had previously expected. In addition, Cat dealers have lowered order rates well below end-user demand to reduce their inventories. Production across much of the company has been lowered, resulting in temporary shutdowns and layoffs. Lower production will continue until inventories and dealer order rates move back in line with dealer deliveries to end users. The reduction in the profit outlook is in line with the lower sales and revenues outlook, partially offset by the gain on the sale of a majority interest in our third party logistics business.

Looking out to 2013, they see continued growth in the 2H of the year. In other words, it's a-hope-and-a-prayer growth forecast with growth backloaded in the forecast period:

From an economic standpoint, we are expecting slightly better world growth in 2013 with modest improvement in the United States, China and most of the developing world, but continuing difficulty in Europe. Based on our economic forecast, our preliminary outlook for 2013 is for sales and revenues to be about the same as 2012 in a range of up 5 percent to down 5 percent.

"We are taking a pragmatic view of 2013—we're not expecting rapid growth, and we're not predicting a global recession. At this point, we expect 2013 sales will be similar overall to 2012, but witha slightly weaker first half and a slightly better second half. While machine deliveries to end users have continued to hold up, our sales will probably remain relatively weak early in 2013 as dealers are likely to continue reducing inventories. When expected dealer inventory reductions level off, and easing actions by central banks and governments around the world begin to improve economic growth, we expect our business will begin to improve. While there's reason for optimism, and we're not expecting a global recession in 2013, we are prepared and stand ready to take action no matter what happens to the global economy," Oberhelman added.

This is a rather ugly outlook from a global bellwether. You would have thought that the stock (and the stock market) would have sold off in the wake of these statements. Well, it did at the open, but CAT recovered to rally throughout the day and finished the day on a positive note.

What's going on?

My inner trader tells me that when a stock or a market rises on bad news, the negatives have already been discounted in the price, which is bullish. Indeed, the conclusion from my last post (see Bearish tripwires) is that intermediate term declines generally do not start with such negative sentiment, outperformance of cyclical stocks and positive momentum from measures of risk appetite.

My inner investor tells me that such uncertain outlook from a global capital equipment bellwether like CAT is a fundamental sign to be cautious.

That's exactly the same message we are getting the VIX term structure, short-term bullish but long term cautious.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, October 22, 2012

As the stock markets weakened on Friday, the SPX closed just under its 50-day moving average, an important level of technical support.

The weakness was confirmed by the Dow Jones Industrials Average:

Is it time to sell everything and turn more cautious?

What the bears need to do
Here is what I think the bears need to do in order to gain the upper hand. First, European markets are still holding above their 50-day moving averages and I would like to see them decline below the 50-day MA to get more bearish. Here is the FTSE 100:

...and the Euro STOXX 50, which is an excellent barometer of stress:

Market psychology needs to get more bullish
Moreover, investor psychology needs to get more bullish. The latest AAII readings show bullish sentiment retreating in the face of a market advance (via Bespoke):

The VIX Index needs to stage an upside breakout above 20:

Moreover, the media was full of stories about the Crash of 1987 and how a crash could happen again. This is not the kind of psychological backdrop from which major declines begin.

Risk appetite is not in retreat
Many measures of risk appetite are not in retreat. Consider the NZDJPY cross rate, which is a key barometer of the carry trade:

The ratio of junior gold mining stocks to the more senior golds is showing a range-bound consolidation pattern:

Here in the Great White North, the ratio of the more speculative TSX Venture Index to the more senior TSX Index is rising, indicating rising risk appetite.

Until we see a broad retreat in risk appetite, I am not ready to declare this bull run over.

Earnings and the economic cycle
What about earnings. It is true that this Earnings Season has been disappointing. Josh Brown put it aptly when he wrote:

Is the weak earnings picture for Q3 the start of a new trend toward lower profitability or a bump on the road to full recovery?

Simple question. It will answer all.

Mr. Market's conclusion so far can be found in the relative performance of the Morgan Stanley Cyclical Index against the market.

The relative uptrend is still intact, indicating that it believes that Q3 earnings are only "a bump on the road to full recovery".

Bottom line: Until I see a broader retreat in the major averages, reduction in risk appetite, the public getting bullish, and relative underperformance of cyclical stocks, I am still inclined to give the bulls the benefit of the doubt.

Speaking tactically, however, we may have some weakness this week. Notwithstanding the minor violation of the 50-day moving average, which could set off some selling, last week was option expiry week and option expiry week tends to have a bullish bias (and it did - up until Thursday). The week after (this week) tends to have a mean-reverting bearish bias. Nevertheless, with an FOMC meeting and many important earnings reports from major bellwether stocks coming out this week, there will be lots of volatility. My inner trader is inclined to buy into any weakness while keeping an eye on the bearish tripwires that I outlined.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Saturday, October 20, 2012

Who believes everything a central banker says? Does Mr. Market swallow everything a central banker tells him without question?

Consider, for example, the issue of quantitative easing as money printing. On October 1, 2012, Ben Bernanke gave a fiery speech in defense of the Fed's monetary policy. In particular, he said that the Fed is not printing money with its QE programs, merely temporarily holding Treasury securities. The Fed will shrink bloated balance sheet by either selling Treasuries or let them mature at some appropriate time in the future [emphasis added]:

By buying securities, are you "monetizing the debt"--printing money for the government to use--and will that inevitably lead to higher inflation? No, that's not what is happening, and that will not happen. Monetizing the debt means using money creation as a permanent source of financing for government spending. In contrast, we are acquiring Treasury securities on the open market and only on a temporary basis, with the goal of supporting the economic recovery through lower interest rates. At the appropriate time, the Federal Reserve will gradually sell these securities or let them mature, as needed, to return its balance sheet to a more normal size.

Bernanke is technically correct in that the Fed hasn't cancelled Treasury debt but "temporarily" holding them. But how credible is that exit strategy? Does anyone really believe that the Fed will normalize its balance sheet in the next few years?

The next logical step is the act of money printing. Gavyn Davies, writing in the FT, discussed the option of actually cancelling debt held by central banks:

One radical option which is now being discussed is to cancel (or, in polite language, “restructure”) part of the government debt that has been acquired by the central banks as a consequence of quantitative easing (QE). After all, the government and the central bank are both firmly within the public sector, so a consolidated public sector balance sheet would net this debt out entirely.

If this was to become a serious option, would the gold market freak out or is this event already discounted by the market because the Fed's exit strategy is not credible?

How credible are central banker statements?
The real question is, "How credible are central banker statements?"
Here is a real-life case of how the markets reacted to central bank actions that should have been discounted long ago. Last week, Bank of Canada governor Mark Carney turned more dovish and hinted that the BoC would not be raising interest rates in the near future.

Duh! Was that a surprise? Would the BoC actually buck the tide by raising rates when global central banks are undergoing an easing/QE cycle?
Apparently, the answer was yes, it was a surprise, according to news reports:

Some currency watchers attributed the loonie’s latest weakness to a speech Monday by Bank of Canada governor Mark Carney that was notable for what he didn’t say and interpreted as a more dovish tone toward the possibility of interest rate increases.

Carney did not include in his speech an often-repeated line that “modest withdrawal of the present considerable monetary policy stimulus may become appropriate.”

Here is how the CADUSD exchange rate acted in the wake of the Carney speech:

Who believes everything a central banker says? Apparently Mr. Market does no matter how outrageous the statement is. It is just amazing.
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Thursday, October 18, 2012

Last week Mark Hulbert warned about the high level of insider sales to purchases:

Consider an index of insider behavior calculated by the Vickers Weekly Insider Report, published by Argus Research, which is based on the ratio of shares sold by insiders to shares bought. Last week, according to the latest issue of the Vickers service, this ratio for NYSE-listed issues stood at 5.13-to-1. The comparable ratio in early September was 5.97-to-1.

He went on to interpret these readings:

To put these numbers into perspective, bear in mind that the sell-to-buy ratio’s long-term average is between 2-to-1 and 2.5-to-1. Vickers consider any ratio below this average to be bullish, and any number above it — like the current level — to be bearish.

At the beginning of the bull market in March 2009, for example, the sell-to-buy ratio got as low as 0.42-to-1, At the stock market’s low in early October of a year ago, at the bottom of that year’s summer/fall correction, the ratio got as low as 1.04-to1.

At its current level of 5.61-to-1, therefore, this ratio suggests that insiders right now are selling between 5 and 13 times as many shares of their companies’ stock — relative to how many they are buying — than they were at those important market lows.

My first reaction was that such a sales to purchase ratio was worrisome for the bulls. But this elevated level of insider selling had been persisting for some time (see Hulbert's September 5 column). What's going on?

Bullish consumers, bearish businesses

One explanation is the divergence between the bullish macro environment, especially for the US consumer, compared to the bearish outlook exhibited by corporate executives. Yesterday's market action was a microcosm of this effect. IBM's earnings release prompted a bearish reaction, but the bullish macro backdrop of the blowout housing numbers overwhelmed the bearish tone from the IBM report.

Take a look at this chart of the divergence between the consumer confidence and business confidence. I proxied the former with the University of Michigan consumer sentiment (in blue) and real retail sales (red) and proxied business confidence with Manufacturers' new orders (green).

Note the recent divergence. Measures of consumer confidence are spiking while business confidence has nosedived.

Which is the right indicator for stock prices? My take is that in the current environment of positive price momentum and Fed easing, falling business confidence, which will eventually translate to lower earnings, won't matter until valuations start to matter.
Investors should view insider sales and flagging corporate confidence as a warning sign. Traders should stay long, maintain tight risk control and enjoy the party being thrown by the Fed, the ECB and global central bankers.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Wednesday, October 17, 2012

As I watched the second round of the Presidential debates, it occurred to me that much of the disagreement is about the role of government in society. In general, the Right would prefer a less intrusive government and the Left would prefer a more interventionist government.

While the debate is all well and good in theory, I wonder how each side views the latest about-face by the IMF giving advice to governments to re-focus their policies away from austerity to growth. FT Alphaville has a great synopsis of how things have changed:

The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.

Translation: Government spending matters more than we originally thought. To explain, the multiplier effect is the effect an action, such as government spending has on the economy. If the forecast multiplier effect is 0.5, then $1 of spending has a $0.50 effect on output, or GDP, i.e. the other $0.50 is "wasted" and therefore inefficient. If it's 1.2, then spending $1 has a $1.20 on GDP and sparks more economic activity.

Ambrose Evans-Prichard, who would rather die than say anything positive about Europe, characterized the IMF change of heart this way:

Drastic fiscal tightening in a string of interlinked countries does two to three times more damage than assumed, especially if there is no offsetting monetary stimulus.

Pushed beyond the therapeutic dose, it is self-defeating. At a certain point it becomes pain for pain's sake.

More government is good under these circumstances then, right?

Micro vs. Macro
Contrast the IMF's macro-economic prescriptions to Mario Draghi's micro-economic approach of internal devaluation under his Grand Plan of structural reform. I wrote about how unit labor costs were converging in Europe, which is one step to solving the problem of North-South productivity gap (see An inflection point for Europe?).

Philosophically, the divide between the IMF and the Draghi ECB is not just an academic question about the proper estimator of the multiplier effect, which is a macro-economic question, but the difference between a macro-oriented solution and a micro oriented solution of getting the environment right to set the stage for sustainable growth.

Boundary problems in modeling
Economists all make certain assumptions with their models, but all models have problems at the "boundary" where the normal conventions of economics do not hold. Some investors, such as Ray Dalio, have openly wondered out loud whether European populations can stand the pain of the draconian solutions being proposed:

Frustrations increase, the established ways of doing things come under attack and frustrations over the ineffectiveness of government creates the perceived need for someone to gain control of the mess. Plato spoke of this dynamic. It was the reason Hitler was elected in 1933.

In modeling, these are known as boundary problems and we risk running into them. That's why Dylan Grice of Société Générale has produced a series of charts outlining this political problem of when Hitlers can arise.

...and how economic stress can make people very, very cranky and start to blame others (via Also Sprach Analyst).

I would characterize these issues of not just a simple philosophical problem of Left vs. Right or micro vs. macro-economics, but also a problem of the political constraints that we operate under. Be careful what you choose, economic solutions often have unintended consequences.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, October 15, 2012

The stock market has been consolidating in a sideways pattern for the past several weeks. While I am still inclined to give the bull case the benefit of the doubt, my analysis of relative leadership (see Momentum + Bull market = Chocolate + Peanut butter) reveals sectoral leadership from both aggressive high beta groups and defensive sectors of the stock market.

For the bulls, I can suggest looking at Homebuilders and Gold miners. The Homebuilding group has been on a tear since last October. Gold stocks have been rallying presumably on the assumption that the latest round of global quantitative easing by central bankers amount to competitive devaluation and gold bullion is a beneficiary because of its status as an alternative currency.

The bears might want to consider the high yielding Telecom sector and Health Care for their defensive qualities. Telecom stocks have been beating the stock market since May, which makes it an ideal candidate for investment regardless of market climate. Health Care has shown itself to be the leadership in this current sideways consolidation period and would likely outperform should stocks decline further.

For the bulls
For the bulls, consider this chart of the relative performance of Homebuilders against the market (top panel) and the stock market (bottom panel). Homebuilders bottomed out on a relative basis last October and they have been rallying on a relative basis ever since. Currently the group is testing a relative support level, but the relative uptrend remains intact. The Fed's QE3 program specifically targets the MBS market, which should benefit the housing sector. This is a signal to get long and don't fight the Fed.

A similar analysis of the gold miners showed this group rallied through a relative downtrend line in late August and they have been in a relative uptrend ever since. Gold should benefit from the latest trend of quantitative easing by central banks around the world, which amount to competitive devaluation that benefits the value of gold as an alternative currency.

Defensive leadership for the bears
In choosing sectors as candidates for investment, I like to see secular leadership independent of market direction. Telecom, which sports a higher than market yield, is usually thought of as being somewhat defensive in nature. Nevertheless, this sector has been leading the market since May. It remains in a relative uptrend and did not lag when the stock market began to run in June. This sector, along with the Homebuilders analyzed above, form the secular leadership in the stock market.

For bearish investors looking for the leadership that is likely to outperform in a down market, Health Care is a leading candidate. The sector has been rallying on a relative basis in the current sideways consolidation period. Should the market go lower, it will likely emerging as a leadership sector.

While I personally remain bullish for now, I have four suggestions for both bulls and bears alike in the construction of their portfolio.

Pick your poison.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Tuesday, October 9, 2012

Reuters reported that the World Bank downgraded China's growth outlook to 7.7% this year from 8.2% and 8.1% in 2013 from 8.6%. It also highlighted the downside risks to the forecast.

The World Bank earlier on Monday released its latest East Asia and Pacific Data Monitor, warning China's that slowdown could accelerate.

In the report, the international lender said that ambitious investment plans announced by several local governments in China could face funding constraints, "not least because governments are feeling the pinch of a cooling real estate market, which lowers land sales revenues".

The World Bank said the central government was unlikely to come up with a major fiscal stimulus package as policymakers were concerned about a rebound in home prices and a possible reversal of hot money flows.

I wrote last week that there were early signs of a turnaround in China's growth outlook (see China dodges a bullet?). Now Macro Man wrote about signs of a bounce in Asian exports, including China.

So, adding it all up, TMM [Team Macro Man] reckon with China back this week, the potential is there for the market to reassess the Asia slowdown trades, because it looks to us as though these are - particularly in China and Australia - past their sell-by date.

While I do take their analysis with a grain of salt because Macro Man is long the AUD and therefore talking their book, these disparate indicators nevertheless form a mosaic picture of a nascent growth turnaround in Asia and China in particular.

In this case, the World Bank downgrade of China's growth outlook may be the nadir of Asian slowdown fears.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest. None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, October 8, 2012

Last week, I wrote that I was willing to give the bull case the benefit of the doubt (see The bull case is still intact) and the equity market's strength late in the week vindicated my view. The market action on Friday was somewhat disappointing for the bulls, as the minor beat on the NFP failed to fully energize stocks for the day. I am becoming more wary of the outlook for stocks as we head into November as there are a couple of important hidden speed bumps for the bulls.

J.C. Parets over at All Star Charts said that investors should beware of the post-election hangover. He quoted Jeff Hirsch of the Stock Traders Almanac, who warned of poor post-election quarterly returns based on historical patterns:

A GOP civil war?
While this is not my base case, I can envisage a scenario where a civil war erupts within the Republican Party that could endanger the fiscal cliff.

Let me explain. Right now, the consensus outlook is that the November election will result in the status quo. Obama retains the White House (as per intrade.com), the Democrats control the Senate and the Republicans control the House of Representatives.

Before you start writing me about how Romney destroyed Obama in last week's debate, I would point out that Business Insider reported that while the overwhelming opinion was Romney won the debate, he didn't win their hearts. Analysis of Twitter shows people still favored Obama over Romney despite the debate result.
Assuming that we get a status quo electoral result, I believe that the market hasn't considered the possibility that the Republican Party could turn on itself. The GOP has been divided between two wings, the Establishment wing, as exemplified by the likes of George H. W. Bush, the classic East Coast Establishment patrician, and the social conservatives, as exemplified by Sarah Palin and the Tea Party.

You could see the tension develop as the presidential nomination battle developed. The social conservatives lost the nomination, but closed ranks with other Republicans and for the sake of the Party. The implicit message was, "You get your chance to make your mark this time."

What happens if Mitt Romney implodes? Could the social conservatives start to point fingers and try to blame the Establishment wing for the loss and split the GOP? If that happens, the Tea Party and their social conservative allies would make an ideological stand in order to differentiate themselves from the Establishment Republicans and send the country over the fiscal cliff like an innocent bystander.
Mr. Market wouldn't like that at all.

Changing of the guard in China
In addition, there is another important event that occurs two days after the US election - the start of the Party Congress in China that marks the change in leadership. Since China's affairs are so opaque, this is another wildcard as important questions remain unanswered.

What is the philosophy of the new leadership?

How will they react to the economic slowdown in China?

There are reasons to be cautiously optimistic, but the level of uncertainty is high. Also Sprach Analyst believes that China's economic cycle is divorced from the political cycle:

In terms of economic growth, the notion that the political cycles have something to do with that appears to be just as superstitious. The chart below from Barclays Capital shows the GDP growth and growth in fixed asset investment and the timing of Party Congress.

In terms of GDP growth, there is no evidence at all that growth will pick up in the following year after the Party Congress. In terms of fixed asset investment, growth picked up in the years following the Party Congresses. Because of the pick-up of investments, some believe that the same will happen again next year.

I also wrote last week that the latest data shows a nascent turnaround in Chinese growth (see China dodges a bullet?) which should be of some comfort for the bulls.

To put these risks into perspective, all these musings are highly speculative and I am not one to second guess my models, which is still flashing bullish and forms the basis for my vote in the Ticker Sense blogger survey. Nevertheless, given the sort event risk surrounding in November, I have to allow for the possibility of significant speed bumps in that time period and my inner trader is watching carefully and very concerned.

Be careful and keep your stop losses tight.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Friday, October 5, 2012

I came upon a couple of data points that seem to indicate that Chinese growth has bottomed and is in the process of a turnaround. First, Also Sprach Analyst points out that Macau gaming revenues, which are highly correlated with Chinese growth, ticked up in September.

In addition, FT Alphaville highlighted a research report by Standard Chartered that concluded that Chinese property market is turning around,

In fact, they say, sales are picking up so much — and unit completion has been so slow — that inventory depletion could be a problem in the second half of 2013, at least in the top-tiered cities.

Meanwhile, land sales are holding steady and possibly rising (the local governments will be relieved), and financing appears to be easier:

My inner bull is breathing a sigh of relief. These developments are suggestive of a nascent turnaround in the Chinese economy.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Wednesday, October 3, 2012

In my last post, I highlighted rising consumer confidence as one of the reasons to be bullish (see The bull case is still intact). The continuing strength of the American consumer has been a puzzle to me, as this has been an incredibly anemic recovery. This chart from Doug Short shows how employment growth has lagged past recoveries.

Despite taking all these hits, the American consumer is not on his back. Doug Short also highlights how important consumer spending is to the American economy. The chart below shows the progress of the percentage share of Personal Consumption Expenditure (PCE) to GDP.

Here's the BIG question: If the economy depends so much on the consumer and the recovery in employment is so weak, why is the consumer showing such surprising strength?

It's housing, stupid!
A Gillian Tett article in the FT may have the answer. Economists think about GDP growth as a measure of how the economy progress, for consumers and the electorate, housing matters a lot more [emphasis added]:

In the financial markets, it is generally assumed that “the economy” is something defined by GDP data; the figures that excite analysts are data on inflation, say, or output and unemployment.

However, if a recent survey from Absolute Strategy Research, an economics research group, is correct, it is not necessarily the GDP figures that matter to voters, nor even just the jobless numbers.

Instead, a crucial – but oft-ignored – factor that shapes how voters feel is that slippery issue of house prices. And judging from the ASR survey, a subtle-but-significant distinction has opened up between how people perceive those housing prices – and the wider economy – which reflects whether people define themselves as Democrats, Republicans, or part of that ever-swelling group of “independents”.

While the main thrust of the article was on voter attitudes affects the November elections, it has economic implications as well. Tett focused on the "crucial importance of watching house prices":

After all, if house prices do rise next year – whether due to quantitative easing, mortgage modifications, an enhanced foreclosure system, or anything else – this could have a big economic impact. Conversely, if the market remains flat, voter anger may swell.

Housing seems to be putting in a bottom here. Calculated Risk has documented this development for the past few months. The Federal Reserve's latest QE plan for an open commitment to buy mortgages should further benefit the housing sector as well.

If the survey results from ASR are correct, then it should feed through to an even stronger American consumer in the months to come.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Monday, October 1, 2012

Regular readers know that I have been bullish for the past few weeks. Michele of The Night Owl Trader agreed in a comment from a past blog post:

I agree. I voted bullish on the poll this week too. It may be unsettling to see people throwing Molotov cocktails in Madrid, but looking at the weekly and monthly SPX charts I'm just not seeing any topping action there despite the recent pullback.

I have generally used daily charts, but her comment about using weekly charts reminded me that they can be a useful perspective for investors who are less interested in the daily ups and downs of the market. A review of the weekly charts show an equity market that remains in bullish mode, though the bulls face a crucial test in the week ahead.

Here is the SPX. The uptrend remains intact, though the index is testing the uptrend line.

The small cap Russell 2000 presents a similar picture. However, while the large caps have pushed through to new highs, small cap stocks are caught between an ascending trend line and overhead resistance as it tries to rally above the 2011 highs.

What about Europe, which was the source of much angst last week? The Euro STOXX 50 remains in an uptrend as well and it is in the familiar position of testing that uptrend line as are the US equity averages.

When I consider market internals, I see a similar picture. The relative returns of the Morgan Stanley Cyclical Index (CYC) against the market shows that it rallied through an relative downtrend line in August and it has begun an uptrend. While CYC has pulled back on a relative basis, the relative uptrend remains intact.

Measures of risk appetite tell the same story. Here is the silver-gold ratio. Silver is the more speculative of the precious metals and tends to outperform gold on the upside. This ratio is now consolidating its gains and show no sign of a relative breakdown, indicating that risk appetite is not in retreat.

Here in Canada, I watch the ratio of the smaller speculative TSX Venture Index against the more senior TSX Index. Risk appetite remains alive and well here in the Great White North.

To summarize, these charts show a picture of a test of a bullish uptrend and I am inclined to give the bulls the benefit of the doubt. However, should the market averages either decline or move sideways, I would have to re-evaluate my bullish views.

As well, Asian economic releases reported overnight told a story of improvement. South Korea's September exports fell by -1.8%, compared to consensus expectations of -5.5%. China's September PMI rose to 49.8 from 49.2 in August, though it fell short of expectations of 50.1. As I write these words, stocks were down in Tokyo but other Asian markets were up.

Despite the general weakness in the Asian and European economies, an important reason to be bullish are the signs of an improving American economy. New deal democrat over at Bonddad blog summarized last week this way:

Almost all of the high frequency data this week was positive, much of it strongly so. Only the three transportation-related metrics were negative: rail traffic, shipping rates, and gasoline usage. All of these suggest considerable coincident weakness in the economy. But the positives were legion: gas prices declined, credit spreads narrowed, corporate bond prices increased, money supply remains strongly positive, overnight rates have sunk into a deep sleep, the recovery in housing continues, employment tax withholding has rebounded, temporary staffing has bounced, and the US consumer continues to spend like a champ! These positives suggest that the coincident weakness will pass rather than deepen. As always, energy prices are a wild card and bear close watching.

We have the all important (though noisy) Non-Farm Payroll figure to be released this Friday. Gallup does a tracking poll and I interpret the results to mean that NFP will either be in line with expectations or beat.

Gallup's poll indicated that the raw unadjusted unemployment rate is expected to tick down but the seasonally adjusted rate to be flat. However, the number of part-time workers looking for full time work is declining, which suggests that under-employment picture is improving.

Another reason to be bullish is initial jobless claims data has also been improving. Joe Weisenthal found an excellent correlation between initial claims and the stock market.

Consumer confidence is also improving. The Conference Board reported that consumer confidence surged 9 points in September and beating expectations. As we approach Earnings Season, that should be a measure of good news for equities.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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Welcome to my blog Humble Student of the Markets. These are my observations and musings about the markets (mostly equities), hedge funds and investments in general.My experience has been a quantitative equity manager in US, Canada, EAFE and Emerging Markets and commentator on hedge funds and their returns patterns.

DISCLAIMERThis is not investment advice! I know nothing about you, your risk preferences, your portfolio or your investment horizon. I have no idea whether any of my opinions expressed are suitable for you.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. I may hold or control long or short positions in the securities or instruments mentioned.